Philip Morris International Inc. — 2011 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. PMI manufactures and sells cigarettes and other tobacco products outside the United States across four geographic segments. Financial statements are unaudited and prepared under U.S. GAAP.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net revenues, including excise taxes | $20.706bn | $16.936bn | $57.470bn | $49.906bn |
| Net revenues excluding excise taxes | $8.362bn | $6.614bn | $23.426bn | $20.171bn |
| Operating income | $3.677bn | $2.836bn | $10.396bn | $8.457bn |
| Net earnings attributable to PMI | $2.377bn | $1.822bn | $6.705bn | $5.507bn |
| Diluted EPS | $1.35 | $0.99 | $3.76 | $2.96 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $9.568bn | $7.856bn |
- Q3 net revenues rose 22.3%; excluding excise taxes, they rose 26.4%. Operating income increased 29.7%, PMI-attributable earnings 30.5%, and diluted EPS 36.4%.
- For the first nine months, net revenues rose 15.2%; excluding excise taxes, 16.1%. Operating income increased 22.9%, PMI-attributable earnings 21.8%, and diluted EPS 27.0%.
- Reported gross margin, calculated as gross profit divided by net revenues that include excise taxes, was 26.6% in Q3 versus 25.5% a year earlier, and 26.9% for nine months versus 26.0%. Operating income divided by revenues excluding excise taxes was 44.0% versus 42.9% in Q3 and 44.4% versus 41.9% for nine months.
- Nine-month operating cash flow increased by $1.7bn, mainly reflecting higher earnings, favorable working-capital movements, and lower pension contributions. Investing cash outflow was $682m; financing cash outflow was $7.054bn.
- Capital returns during the first nine months included $4.367bn of share repurchases and $3.441bn of dividends paid. Dividends declared were $2.05 per share for the nine-month period. In Q3, the board raised the quarterly dividend 20.3% to $0.77 per share, an annualized rate of $3.08.
Balance sheet, debt, and liquidity
- At September 30, 2011, cash and cash equivalents were $3.391bn, total assets $36.220bn, and total liabilities $32.566bn. Stockholders’ equity was $2.438bn, including redeemable noncontrolling interest shown separately at $1.216bn.
- Total debt was approximately $17.8bn, up from $16.5bn at December 31, 2010; cash less total debt implies net debt of approximately $14.4bn. Short-term borrowings were $2.563bn, current long-term debt $2.326bn, and long-term debt $12.870bn.
- Current assets of $15.090bn were below current liabilities of $16.050bn (current ratio approximately 0.94). Cash increased from $1.703bn at year-end, while the current portion of debt and accrued liabilities increased.
- Committed credit facilities totaled $5.2bn at quarter-end, with no facility borrowings outstanding; commercial paper outstanding was $2.1bn. An October 25, 2011 facility agreement increased committed facilities to $6.0bn. The covenant minimum EBITDA-to-interest ratio is 3.5x; PMI reported 15.6x at quarter-end.
Changes, drivers, and management outlook
- Excluding acquisitions, cigarette shipment volume increased 0.5% for nine months and 4.4% in Q3. Total cigarette volume rose 2.0% and 4.5%, respectively, with the Philippines combination contributing to the reported growth.
- Asia was the strongest reported operating segment: nine-month operating companies income rose 68.2%, supported by price increases, favorable volume/mix and currency, and the Philippines acquisition. Q3 Asia operating companies income increased 89.7%. Japan shipments benefited from competitors’ supply shortages following the March 2011 earthquake and tsunami; management estimated an approximately $0.15 EPS benefit for the first nine months.
- Growth also reflected pricing and favorable currency; these benefits were partly offset by higher manufacturing and marketing costs. European Union cigarette volume and market share declined amid contracting markets, tax-driven price increases and weaker conditions in some countries. Mexico and Pakistan faced market or illicit-trade-related volume pressure.
- Management narrowed 2011 full-year reported diluted EPS guidance on October 20 to $4.75–$4.80, from $4.70–$4.80. This implied growth of approximately 21%–22.5% over 2010 reported EPS of $3.92. Excluding forecast favorable currency of about $0.20 per share, projected growth was approximately 16%–17.5%. Guidance excludes potential acquisitions, unanticipated impairment and exit costs, and unusual events. Adjusted EPS is a non-GAAP measure.
- Nine-month effective tax rate was 29.1%, compared with 27.0% in 2010, mainly because prior-year discrete tax benefits were larger. Q3 rate was 29.4%, versus 27.8%.
Risks, contingencies, and unusual items
- PMI reported $60m of nine-month asset impairment and exit costs, versus $20m in 2010, primarily for factory and R&D restructuring and a distribution-contract termination. Approximately $32m of remaining exit-cost payments were expected to be substantially paid by the end of 2012.
- Tobacco litigation remains a material uncertainty. PMI said it had not concluded that losses in pending tobacco cases were probable or estimable and had therefore accrued no estimated losses; it warned an adverse outcome could materially affect a quarter or year. Some claims in Brazil, Canada, Israel and Nigeria seek damages in the billions.
- Thai authorities’ investigation alleged approximately $2bn in customs and excise underpayments for 2003–2007 and approximately $1.8bn for 2000–2003. The Public Prosecutor issued a non-prosecution order on the first matter, but the Director-General of DSI disagreed and referred it to the Attorney General. PMI disputes the allegations; the WTO had found no basis for Thailand’s asserted under-valuation in a related trade dispute.
- Regulatory and market risks include further excise-tax increases, advertising and product restrictions, ingredient and disclosure rules, larger health warnings, plain-packaging proposals, smoking restrictions, illicit trade, and economic or currency volatility. Australian plain-packaging legislation was pending Senate consideration; PMI had served notice of a potential investment-treaty arbitration.
- Foreign exchange derivatives had $11.5bn aggregate notional value at quarter-end and were used for risk management, not speculation. Management disclosed no material change in risk factors from the 2010 Form 10-K. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether full-year EPS guidance is achieved and how much growth is attributable to currency, pricing, buybacks, and temporary Japan supply disruptions.
- Whether cash generation can sustain dividends and repurchases while debt, near-term maturities, and current liabilities remain elevated.
- Developments in the Thai customs investigations and significant tobacco litigation, including whether any loss becomes probable and estimable.
- Regulatory developments, particularly excise taxes, plain packaging, product rules, and their potential effects on volume, pricing, and illicit trade.
- Segment trends and market-share performance in the EU, Mexico, Pakistan, Japan, and the Philippines, separating organic performance from acquisition and inventory effects.